Binary Equation Strategies for FOREX
Binary equation strategy (BES) is credited to the 18th century mathematician Jean-Baptiste le Rond d'Alembert. It is a betting/trading strategy similar to a "martingale": a bettor or trader increases the amount at risk after a loss and decreases it after a gain. BES is a money-management strategy; it tells you how much to trade, not what to trade. The idea is that a win that follows a loss will recoup the loss and yield a net profit. It is based on a mathematical fallacy that a streak in one direction increases the chance that a reversal is due. In fact, if you believe that market pricing is an essentially random process, then each new outcome is independent of what has previously occurred, and streaks in no way predict the outcome of the next event.
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History
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D'Alembert (1717--1783) was a French physicist, philosopher, musical theorist and mathematician. While acknowledged as a productive scientist, he is most famous for his incorrect argument that the probability of a coin landing heads made it more likely that the next coin toss would result in tails. Subsequent probability theory proved that each toss was a 50-50 proposition regardless of previous tosses. His system of betting more when losing and less when winning was originally called the D'Alembert system; in modern FOREX markets it's called BES.
Currency Pair Example
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You start with any trading strategy that produces position entry signals for a pair of currencies -- the choice of trading strategy is up to the trader and produces separate decisions from those based upon BES. You place an order for a pair of currencies (you buy one currency and sell the other) based on the trading strategy, simultaneously placing take-profit (closing a winning position) and stop loss orders (closing a losing position) at equal distances from the trade entry price. BES states that If you lose on your first trade, you double your investment on your next one. Follow this strategy until you have a winning trade, and then quit for the day. Mathematically, you will have a profit for the day as long as your last trade was a winner. Of course, the fallacy of the system is that you can't count on having a winning trade before you run out of money.
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Reverse Strategy
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A reverse BES (known as a Contra D'Alembert strategy) is one in which you invest the same amount on each trade until you have a winning trade, at which point you increase your investment. If you win again, you are in a two-trade winning streak, and you keep increasing your investment by just one unit -- this is not a doubling strategy -- until some self-imposed limit or you encounter a losing trade. In the case of the latter, you start all over again. Whether you use a regular or reverse BES, the mathematical likelihood is that sooner or later you will hit a long losing streak and be wiped out. Psychologists label the over-expectation of streaks and reversals "clustering illusion," and it has been the downfall of many traders.
Binary Options
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A modern variation on BES is practiced using FOREX binary options. These are FOREX options traded on the North American Derivatives Exchange (NADEX) and elsewhere in which a trader collects a fixed amount, usually $100, if current prices reach a certain price -- the target price (strike price) of an owned binary option -- before the option expires. Expirations occur on a daily and weekly basis, and the price paid for the option (the premium) is determined by the amount of time until expiration and the difference between the current price of a currency pair and the strike price of the option. If the current price fails to achieve the strike price before expiration, the premium is forfeit. Traders employing BES look to string together two or more consecutive winning binary option trades, but otherwise the strategy is very much like FOREX currency pair trading using BES, and just as risky.
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References
Resources
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